Weekly Update: RIP my huckleberry friend
News of this week’s death of Andy Williams got me feeling nostalgic. I loved his Christmas specials and his rendition of “Moon River.’’ It sure seemed to be a simpler time. I mean, look at what we’ve become. Yesterday, the market had a big strong move because of Spain’s willingness to take a bailout! In China, investors have generally responded positively to the growing weakness because they think it will prompt government stimulus! And we all know what the Fed is doing—QE to infinity and beyond. As I traveled this week in North Carolina and Alabama, in almost every meeting we had, there were comments about how we are racing to the bottom as all areas around the world are trying to devalue currency. I met with one of the two most bearish advisers I have ever met, a bond trader whose resume is extremely impressive, and his big concern is the Fed’s exit strategy. Chairman Bernanke says don’t worry, we can do it. But once bond traders get even a sniff of an exit strategy, they are going to make it very expensive. So this adviser is worried about hyperinflation. Maybe he’s right. Who am I to say? On the other hand …
… I’m reminded of the Ned Davis book, “Being right or making money.’’ It’s all about focusing less on forecasting and more on when to add to or pull back from the market. I’ve been reading and hearing a lot in this past week that more people think we’ve seen the highs for the year, and I think we might be seeing some nervous nellies wanting to book profits before the quarter end. I am inclined to think maybe the highs have not been seen—not when everyone seems to be talking stimulus, and not when the “scary month for stocks’’—25% of all crashes happen in October—is kinder than the historic waterfall declines suggest (-21.8% in 1987, -19.9% in 1929, -16.9% in 2008). Yardeni Research notes that, since 1928, the S&P 500 has increased 0.4% on average during October. Over that nearly 85-year period, the S&P rose 60% of the time, gaining 4% on average. It fell 40% of the time, losing 4.9% on average. And Octobers during election years (that were in a bull market and not in recession) were positive 80% of the time. In looking at the annual return of all major bull markets since 1935, JP Morgan says that the fourth year has been strong, resulting in gains that are higher than seen in years two and three. The current fourth year (March 2012-March 2013) has only advanced 5%; a 15% gain implies S&P 1,600 by March. (I’m not making a prediction here.)
Historically, P/Es have expanded to 16 times as well. At 14 times currently, this bull market is below the average of the eight lasting at least four years and has a lower P/E than all but two. At 16 times, the S&P would trade at 1,660. (Hmm.) Thus, the upside potential is driven by a P/E re-rate. Since the start of the second-quarter earnings season on July 1, the projected third-quarter earnings growth rate for the S&P has fallen to -2.2% year-over-year from +3.1% and from a +15.0% forecast a year ago. If the third-quarter finishes negative year-over-year, it would be the S&P’s first such negative comparison in three years. Of the 30 firms issuing guidance since Sept. 12, 27 have been to the downside while only three have been to the upside. That is a 9-to-1 ratio of downgrades to upgrades. Typically it’s somewhere between 1.2 and 2.0 to 1. This is particularly bad. But it also is helping make expectations very low for the mid-October earnings season. What if it’s not as bad as the preannouncements suggest? Hmm.
Confidence creeping up The Conference Board’s confidence gauge rose sharply in September to a 7-month high, led by a sharp rise in expectations, and gains were broad-based across most categories. August was revised up, too. The University of Michigan’s final take on September sentiment slipped slightly from its initial estimate but was still up significantly from August, led by rising expectations and by respondents reporting hearing more about job gains than job losses for the first time since May. This should be good news for consumer spending, as the “expectations’’ components of both gauges historically have presaged consumption patterns.
More signs of housing recovery August new-home sales remained close to July’s two-year high, with year-over-year sales up 28%. August pending home sales did slip from an upwardly revised July, in part because supply was limited, leaving the gauge—a good indicator of future existing home sales—unchanged since June but up 9.6% year-over-year. Separate indices from Case-Shiller and the FHFA showed prices continuing to rise, with the year-over-year increase in the Case-Shiller index the most since tax credit-induced increases in August 2010. The reports, coupled with near record-low mortgage rates, suggest housing will continue to be a rare bright spot in an economy that has been muddling through.
There’s always gold Following gold’s 15% rally since June, the metal is near a breakout point. The spot price would need to move above $1,880 per ounce to break all-time highs in real terms, while it would need to hit $2,960 per ounce to represent an excessive valuation versus the S&P 500. The next objective on gold is $2,200, the top of the long-term upward price channel from 2008.
This won’t help Q3 GDP After factoring out the impact of higher energy prices, inflation-adjusted personal spending edged up just 0.1% in August and real disposable income fell for the first decline in nine months. The tepid data threaten the sustainability of recent consumer spending gains and adds to the picture of final demand growth that has slowed materially in recent months, across household, business and export sectors. This weakening was reflected in the final estimate of second-quarter GDP growth, which was slashed from 1.7% to 1.25% on broad-based adjustments to personal consumption, non-residential fixed investment and inventory accumulation. This doesn’t bode well for the second half, particularly with manufacturing slowing and real spending running at a 1.7% annual rate through the middle of third quarter, little different from the second-quarter’s pace.
Manufacturing outlook cloudy Although most of the decline was due to volatile aircraft orders, August durable goods orders fell much more than expected, with orders ex-transportation also surprising to the downside. Core capital goods orders are now down 5% on the year. On top of last week’s negative Philadelphia and New York Empire readings, the Chicago PMI also dipped into contraction territory in September. This suggests Monday’s national ISM is likely to be below 50 a fourth straight month. Other regional indices were mixed. Both the Dallas and Richmond Fed reports surprised, with Richmond experiencing a sharp jump in shipments and new orders. But the Kansas City Fed said September’s rise in manufacturing activity was less than expected.
Canaries in the coal mine? The Chicago Fed National Activity Index came in negative for the sixth straight month, dropping the three-month moving average to its lowest level since June 2011, indicating below-trend growth. Meanwhile, economic bellwether Caterpillar cuts its earnings forecast for 2013, citing weakness in the world economy. And in Germany, the bulwark of the eurozone, unemployment rose a sixth straight month while business sentiment fell straight month to its lowest since early 2010, raising fears of recession.
Why entitlement reforms are a must Spending on entitlements has gone from 30% of all government spending in 1970 to over 65%, and continues to climb. Raising taxes alone will not be adequate, and we need to make changes to Medicare, Medicaid and Social Security. The revenue side is also a problem with revenues as a percentage of GDP falling to 15% in recent years from an average 17.8% since 1950.
Election Watch Obama has 526 campaign field offices in the swing states, compared to 251 for Romney … If Romney is going to win the election, he must win Florida and Ohio. He currently trails in polls in both states … We have had three wave elections in a row. In 2006, independents voted for Democrats by a margin of 18 points, and in 2010, independents voted for Republicans by a margin of 19 points … Rasmussen suggests that if people feel even a little better about the economy on Nov. 6, Obama will win reelection. It also notes that only 7% of voters today believe that national security issues are the most important issue in this election.
Good call The NFL and its referees reached agreement, ending three weeks of agony with replacement refs. The Lingerie Football League said it fired “a couple crews which apparently [were] now officiating in the NFL” because of incompetence. And rumor has it that NFL Commissioner Roger Goodell believes that the replacement refs’ intemperate calls were due to a provocative video about them that Green Bay fans had posted on YouTube.